SACRAMENTO, Calif. - The $80 billion California Public Employees' Retirement System sharply increased its equity allocation to 63% from 49% of assets, giving it one of the most aggressive equity profiles among pension funds.
The new allocation will mean a shift of about $8 billion out of fixed income as the fund's allocation to domestic bonds will shrivel to 24% from 37% of assets. The fund intends to make the move over three years by investing in market declines and dollar cost averaging.
The dollars being shifted don't include new contributions from employers. and employees, which will be another $1.5 billion a year, said Kevin Morrill, administrative manager.
According to Pensions & Investments' 1993 survey of the 1,000 largest pension funds, defined benefit funds on average had an equity allocation of 49%, while the more aggressive corporate defined benefit plans had an average equity allocation of 53%.
The California fund's equity figure doesn't include the 7% in real estate, which some pension funds consider equity or a partial equity investment.
But fund trustees say Sheryl Pressler, the new chief investment officer, wanted the higher equity allocation. She was backed up by two consultants, Pension Consulting Alliance, Studio City, Calif., and Wilshire Associates, Santa Monica, Calif.
In making the jump to a high equity allocation, the trend-setting fund is expected to influence other pension funds to increase their equity allocation.
Although alternative investments and private equity investments are popular with pension funds now, the biggest new bets for CalPERS on equity will be in the domestic and international stock markets. With $80 billion under management, only the international and domestic stock markets have room for a multibillion dollar cash infusion.
The fund is boosting its domestic equity allocation to 38% of assets from 33%. The fund will increase its international equity investments to 20% from 12%. While opinions vary on how the domestic stock market might do in the coming year, the U.S. stock market is expected to sharply outperform bonds over the longer term. The asset allocation CalPERS is making is a long-term move.
The fixed income bet will be down sharply to 30% from 40%. Domestic fixed income will take the biggest hit, falling to 24% of assets from 37% of assets. The allocation to real estate was decreased to 7% from 8%.
The staff believes the allocation change will bring in about $800 million more a year in investment return over the long term. "That's a lot of money," said Mr. Morrill.
Mr. Morrill said the fund estimates domestic and non-domestic stock investment returns will increase to 10.5% from 10%; private equity returns will increase to 12% from 11.5%; and alternative investment returns will increase to 15% from 14.5%.
Wilshire Associates did predict an increase expected return from domestic and international bonds to 7% from 6.5%. However, that bond return is still far below the return from equities.
Laura Wallace, an investment officer for the Nevada Public Employees' Retirement System, said a 63% equity allocation would create "too much volatility" for the Nevada fund. It has a 40% equity allocation.
Jake Petrosino, CalPERS trustee, said the 63% equity allocation is higher than he is "comfortable with."
But Charles Valdes, chairman of the CalPERS investment committee, said: "I don't think we are out on a limb. Our analysis clearly demonstrates (the fund) doesn't have to be concerned about volatility in the short term." Mr. Valdes pointed out the pension fund has "positive cash flow" - new dollars coming in exceed benefits paid out.
He added the fund is a long-term investor and the board decision wasn't "lightly considered."
One step the board took in making the decision was holding a "very long" workshop that included William Sharpe - winner of the Nobel Memorial Prize in economics - and investment experts from the New York-based investment banking houses of Salomon Brothers Inc. and Goldman Sachs & Co., said Mr. Valdes.
The fund's equity investment includes private equity, alternative investments and timber, said Mr. Morrill. However, the fund hasn't changed its allocation to private equity; it remains at 2% of assets. The allocation to alternative investments increased only one percentage point, to 3%.
None of the main consultants - Stephen Nesbitt, a senior vice president in charge of Wilshire's consulting division; Roz Hewsenian, Wilshire's consultant for the California fund; or Alan Emkin, managing partner of Pension Consulting Alliance - could be reached for comment.
Wilshire recommended that the fund increase its equity investment in a strategic asset allocation study prepared in November.
According to the Wilshire report, "this recommended shift in asset allocation is also predicated on the fact that bond yields are still below (the fund's) actuarial assumed rate of interest, and below any rate of interests (the fund) could assume if the actuarial rate was changed."
Wilshire proposed an equity target of 60% for the California fund.
That report said the domestic and international fixed income expected return will be 7%. On the other hand, Wilshire estimated that even new money to real estate will have an expected return of 8.5%.
According to Mr. Petrosino, a key push for the equity allocation for the California fund came from Ms. Pressler. He said she wanted "even heavier exposure" to equity than the 63% adopted target.
However, Mr. Morrill said the decision was a "collaborative effort." "The board made the decision based on all the input," he said, adding Ms. Pressler "has input as CIO."
Mr. Petrosino said: "I don't think they (fund officials) can tolerate the negative variance" the new equity allocation will bring; the new allocation "is too risky for a public pension fund."
Key supporters of the new equity allocation policy "are trying to make more money in recognition of state financial conditions," said Mr. Petrosino.
"They have the same mentality as we have in Orange County - go by the numbers. They are convinced that over time they will make enough money by taking greater risk and won't have to raise contribution rates for employers," said Mr. Petrosino.
